07/22/2022: How To Get Started in Real Estate Investing
Real estate can be a great long-term investment with the potential to generate ongoing passive income. While it can be daunting to know where to begin, we’ll cover some of the basics, so you can make sure investing in real estate is right for your situation and goals!
Learn about the market
Researching the real estate market to learn more about the neighborhoods and properties is a vital step when getting started in real estate investing. You’ll want to know about the following things:
- Is the location desirable? The location of a property is often the determining factor in its profitability. Aside from its proximity to various markets and transportation hubs, other factors such as the status of the neighborhood and green space also play a role in the valuation of commercial properties.
- Review the area’s current ownership and intended uses. One of the most effective ways to do this is to contact the local government agencies that are responsible for planning and zoning. This will allow them to provide you with a comprehensive view of the area’s long-term outlook.
- Look into the economy and the job market. Understanding the demographics of the area will help you figure out whether or not a specific city is a sound investment location. Many people, especially millennials are attracted to cities with robust economies and competitive employment markets. Rentable property may be more in demand as a result.
- Business performance. Typically, a rise in commercial real estate indicates a strong local economy. This will pique purchasers’ attention, and as more homes are sold, the cost per square foot of real estate will climb.
Analyze and research properties
As you are looking at properties, it is important to analyze and research each property so that you can determine if it makes sense financially and fits into your overall strategy.
Understand the value of the property by looking at its price per square foot, recent comparable sales, and estimated market value. The cost per square foot is important because it helps you determine whether or not there is an opportunity for profit in buying and selling this particular piece of real estate.
Understand what cash flow will be available from operating expenses like mortgage payments, insurance premiums, maintenance costs, management fees/expenses etc. These numbers should also be compared against rental income so that they are accurate before moving forward with purchasing any type of investment property.
Tip: Some companies like Colliers provide free reporting on the current market rents and vacancies.
Determining ROI or Cash on Cash Return
Return on investment
When looking for a good investment property, you’ll need to consider the return on investment (ROI). The ROI can be calculated by first finding the property’s net annual income; this is the rent money that’s left over after you’ve paid the taxes, insurance, property management fees, expected repairs, potential vacancy periods, HOA fees (if applicable) and any utilities that will not be covered by the tenant. Once you’ve figured out the annual income, divide it by how much you’d spend on the property. For example, if the net annual income is $8,000 and you’re going to spend $100,000 on the property, your ROI would be 8%.
Cash on cash return
But it can often be challenging to apply return on investment (ROI) to rental properties because it calculates returns as a function of equity or appreciation. Another forecasting tool is a cash-on-cash (COC) return. This calculation compares the net income generated by a property to the original cash investment used to buy that same property. In other words, (COC) return reveals how much of your out-of-pocket funds you are recovering annually.
Example: Let’s say the potential investment costs $200,000 and you take out a mortgage, putting 20% down ($40,000). The monthly upkeep costs $1,000, then your annual pre-tax cash flow is $24,000: ($3,000 – $1,000) x 12 months. You also have to pay $1,000 every month towards your mortgage. That means your pre-tax cash flow—the money you take in from the property after debt service—is $12,000: ($3,000 – $1,000 – $1,000) x 12, and your (COC) return is 12,000/40,000, or 30%.
Tip: Investors tend to agree that a projected return of between 8 and 12 percent signals a wise investment.
Investors should always plan for the unexpected. A cash flow crisis can happen to even the savviest investors, but those who anticipate and plan ahead will likely be more successful than those who do not. A generally accepted rule is to have between 3 to 6 months of operating capital in reserve.
Gain experience with smaller investments
The best way to learn is by doing, and it’s ok to start small. The first property you purchase could be a fixer-upper. You make an investment in a home that is underpriced and in need of some work, remodel it as affordable as you can, and then resell it for a profit. The tactic, known as house flipping, is a little more difficult than it appears on television. But if you’re a fan of HGTV, you may already have some great ideas!
Keep in mind: The largest error that novice home flippers frequently make is underestimating the price of buying and renovating the property. As a house flipper, you are placing a gamble that you can increase the price at which you sell the refurbished home before rising costs completely eliminate your profit margin.
Another option is to purchase a multi-unit home, which you could live in while renting out additional units. Find a property with total expenses less than what you may charge for rent. You may also need to hire a property manager if you don’t want to be responsible for handling maintenance.
Keep in mind: Sometimes renters will mistreat your property. Always carefully screen potential tenants, but remember there’s no assurance you won’t experience issues.
A real estate partnership may be an option for you if you’d like to invest in a rental property but lack the resources (or knowledge) to do so. Simply put, an investing partner contributes to the deal’s financing in exchange for a cut of the profits. Remember that a partnership isn’t a quick fix to avoid doing any labor. You still need to complete your research, practice your sales speech, and be prepared to convince potential investors that the investment is profitable.
Tip: You can search for real estate investors for a partnership in several ways: through bank financing, a real estate investment club, crowdfunding, your current personal or professional network, and online resources such as social media.
For new investors, the question of how much rent to charge can be a difficult one. Experienced investors sometimes use the 1% rule, which states that the rent should be at least 1% of the purchase price. For instance, if you purchased a house for $100,000, you would need to charge – at the very least – $1,000 for rent. To assess the potential return on a property, obtain rental estimates for similar area properties.
Once you have a property in mind, there are a number of ways to finance your investment.
Keep in mind: True investment property loans are based on the idea that you won’t be residing in the home you buy and will be renting it to tenants to generate income. If you want to reside in one of the apartments, you may also use various common lending programs to buy multifamily investment properties.
- Conventional loans. The only standard loan program that allows you to buy an investment property with no strings attached is the conventional loan program. Unlike government-backed mortgages, you don’t have to live in the property to qualify.
- FHA loans. You can buy a two- to four-unit home with a mortgage backed by the Federal Housing Administration (FHA) and collect rent on the other units to qualify, as long as you live in one of the units for at least 12 months.
- VA joint loans. This VA multifamily loan program is exclusively for eligible military borrowers. It allows them to buy a property with up to seven units, as long as they live in one of the units. The U.S. Department of Veterans Affairs (VA) guarantees these loans with no down payment requirement.
- Non-QM loans. Borrowers that don’t qualify for any of the programs above may be eligible for a nonqualified mortgage (non-QM) loan based exclusively on the rental income received on the home they’re buying. The down payment requirement and interest rates are higher than with regular loan programs.
- Owner financing. Sometimes sellers are willing to act as a lender and provide temporary financing so you can purchase the home in exchange for a large non-refundable down payment. Some owner financing arrangements include a balloon payment, which means you’ll have to pay off the entire loan balance within a set period, or the owner takes back the property.
- Home equity loan. If you currently own a home with a good chunk of equity, you can borrow against the equity with a home equity loan or a home equity line of credit (HELOC). With home equity loans and HELOCs, you borrow a portion of your equity and leave your current mortgage loan in place. A home equity loan is paid in a lump sum with a fixed rate, while a HELOC works more like a credit card that you can use and pay off for a set time.
- Cash-out refinance. A cash-out refinance is when you take out a mortgage for more than you owe and pocket the difference in cash, which can be used to purchase an investment property.
- Hard money loans. These loans are more common for flipping investors — hard money investors are willing to lend you money knowing you’ll pay it off quickly. However, you’ll often need at least a 25% down payment and will pay high rates and upfront points. And it’s not uncommon for there to be a prepayment penalty.
Certain loan requirements may be unique to investment properties. You should visit with a loan officer to understand the specifications.
The right team
Choosing the right realtor to work with is extremely valuable. From researching properties, to negotiations and contractual support, an experienced realtor can make all the difference. When your time and money are on the line, remember to select a realtor that specializes in investment properties and choose a residential realtor for the 1-4 family multi-units.
Real estate can be a great way to build wealth
Real estate investing can be a terrific method to generate monthly income flow, benefit from appreciation, and position yourself to achieve future goals. If you’re thinking about investing in real estate, make sure you have the right support and work with knowledgeable lenders experienced in real estate lending.